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Tuesday, November 29, 2016

Frank Newman: The interest rate worm has turned

The interest rate worm has turned, according to the
latest ANZ Bank Property Focus Report. Their commentary signals a significant
shift in the way the Bank sees things heading.

With respect to mortgage strategy they say, "Although
the OCR has been cut by 25bps, this merely offset a rise in funding costs, and
as a result, no banks have cut their floating mortgage rates. Rises seen for
some longer-term fixed rates reflect both higher funding costs and the sharp
rise in wholesale interest rates that has occurred since August. We believe
mortgage rates have seen their lows, and although there is real pressure for
them to rise further, we caution that rises are likely to be gradual. Nonetheless,
given how flat the mortgage curve is, for the first time in a long time we
believe it is worthwhile considering fixing some portion of your mortgage for
longer than 1-2 years."

The shift here is that they no longer believe mortgage
rates will decline. That means the time is right to switch from 1 to 2 year
fixed rate mortgages to 3 to 5 year terms.

Part of the reason for the worm’s change in direction
is the fundamental shift going on with government policy in the US. President
elect Trump has signalled he wants to make America great again by
spending up large on infrastructure projects. That will invariably push up
interest rates in US and that will flow through to the cost of money
internationally. In New Zealand banks rely on overseas money to fund their
lending so if the cost of money goes up, they must increase their lending rates
to recover that cost.

They also sounded a warning about house prices. They
said, "Another key financial stability risk is housing affordability;
it is absurd, particularly in Auckland. Auckland house prices trade at a
multiple of 9½ times incomes and first home buyers buying the median-priced
house on typical terms now have to commit half their after-tax income to
meeting minimum mortgage payments. That is not much room to move in the case of
unexpected developments, whether that’s ill health, job loss, pregnancy,
divorce or any of the other curve balls life can throw, let alone highlighting
the sensitivity to the possibility of higher future interest rates."

There is a fundamental problem with low interest
rates. It's the same problem that arises when booze is free - people consume
too much and the consequences are not pretty. Those who have filled their
pockets with cheap money and lived the high life will come badly unstruck when
interest rates rise, as they inevitably will. For them, the good times will be
over - savers will be able to pick up their assets at a discount. The worst
will be in Auckland.

On the positive side, the New Zealand economy is
strong. It was surprising to hear the Prime Minister talk about future growth
as being like a "Hockey stick", a term usually used by global warming
alarmists to describe runaway and catastrophic climate change. Clearly the PM
is pretty bullish about the state of the government's books, so much so that he
thinks increased government spending, debt repayment, and tax cuts are all
achievable in the future.

Another positive is the strong rise in population
numbers. It's a truism that property prices follow people so if you can pick
population movements you can pick property prices. The ANZ say, "Migration
flows to and from New Zealand are one of the major drivers of housing market
cycles. The early-1970s, mid-1990s and mid-2000s booms coincided with large net
migration inflows. On a three-month annualised basis, net permanent and
long-term migration rose to a strong 72,700 in October, which is around 1½% of
the resident population and at all-time highs…We are not expecting annual net
inflows to ease back to the long-run average of around 15,000 any time soon.
Due to its economic out-performance, perceived safety and political ructions
elsewhere, New Zealand will remain an attractive destination for
migrants."

So now is the time to think about the property and
money markets entering a new phase. As always, we don't know how quickly things
will move but now is the time for risk averse investors to exercise some
caution. Interest rates are likely to be entering an up cycle while property
prices are showing signs of flattening out.

1 comment:

KP
said...

It all sounds good, but believing what a politician says always leads to disaster.

A better measure would be an economic metric like the Baltic Dry Index, the cost of shipping a container around the world. Its at 760 currently, where it was in 2012 and in 2001. This shows the desperation of shipping companies to get business, and they aren't making any more money than 15years ago, in fact less as inflation and Govt cost have destroyed their profits.

It was 10times that value in between, showing that world trade is running at 10% of what it was. With the world Govts printing money hand over fist until the world is awash with debt, a rise in interest rate will be catastrophic.

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